1/25/2010 @ 5:29PM

Obama Plans to Cut Student Loan Payments

President Obama will propose a plan to cut the student loan payments of millions of Americans during his State of the Union address, the White House announced Monday. The president’s plan would cap payments on federal loans at 10% of a borrower’s income above a set minimum, defined as 150% of the poverty level for the borrower’s family, and allow loans to be forgiven after 20 years instead of 25.

For borrowers with a family of four, the federal poverty level is $22,050. Under the president’s plan someone who earns less than 150% of that amount, or $33,075, would owe nothing on a monthly basis. Those with higher incomes would have monthly student loan payments that equal 10% of their income above $33,075.

Currently borrowers can apply for income-based repayment plans that cap student loan payments at 15% of their income above the basic poverty level. A person who makes less than 150% of the poverty level will not have to make any monthly payments, though they will still be liable to repay the principal and interest charges will continue to grow.

If enacted, the new policy would cost the federal government as much as $1 billion over five years, according to Mark Kantrowitz, a student loan expert and publisher of FinAid. It would apply to Direct, Stafford, Grad Plus and consolidation loans but would not be available for private student loans.

Under the new plan a borrower with an adjusted gross income of $30,000 who owes $40,000 in student loans would pay about $115 a month to service his student debt, down from $170 a month under the current system.

Both figures are well below the burden a borrower would face in the absence of income-based repayment caps. To pay off a $40,000 debt without such caps over the standard 10-year loan period requires payments of $460 a month, assuming a fixed 6.8% interest rate.

Under the current income-based repayment system, a person’s monthly payments rise along with his income. Any debt not paid off after 25 years is forgiven, although the government regards the forgiven balance as income for tax purposes.

Those who go into government work receive additional benefits under income-based repayment. Public health workers, law enforcement officers, public school teachers and other government employees can stop making payments on federal student loans after only 10 years. Any unpaid balance is forgiven with no taxes due.